You’ve put some process in place for calculating bids to ensure that the fee you charge for your service covers your cost of operation. You’ve figured out what you have to charge per hour for your employees to break even. But of course, you’re in business to make a profit. So you have to add some dollars to the break-even rate.
For most businesses, calculating this figure is a two-step process. I recommend starting by figuring out how much money you want to make annually (before taxes). Divide that number by the number of hours you have to sell (number of employees times 1,920). That’s the amount you have to tack on to the break-even rate. Example: You want to make $60,000 per year. That means you have to add $10.41 to the break-even rate. That’s step one.
But targeting your profit is not quite that simple. Most small business owners in the service sector start out by doing all the work themselves, and gradually hire employees as the business grows while continuing to do some of the work themselves. If that’s your situation, all of your profit will not come from marking up employee wages. Some of it will from charging for your own labor.
To calculate what that number is, you need to know how many hours you are spending doing billable work (vs. how many hours you’re spending running the business). Surprisingly, most business owners don’t know — or they vastly overestimate — the number of hours they actually work on jobs. My advice is: Don’t estimate. Keep careful track of your hours for a month in a notebook or on your computer. No matter how much you hate it, complete this exercise so that you have an accurate number.
With that number in hand, here’s how to calculate the profit component of your mark-up. First, set your annual income target (before taxes). Second, subtract how much you’ll earn through your own labor. Third, divide the remainder by the number of employee hours you’ll bill during the year. The result is a figure that tells you how much you need to tack on for profit to meet your minimum goal.
I’m painfully aware that after doing all these calculations you may come up with an hourly rate for your employees that looks too big. But, at least you’re facing reality. And once you’ve done the math, you can make realistic decisions based on reliable numbers.
There are some obvious options to consider when you face the numbers: You can work more hours yourself. You can cut your indirect costs (e.g. by moving to a home office instead of renting one). You can accept a lower annual salary. But the one I like best is to figure out how to make your service more valuable to your customers so they’re happy to pay more.